January 06, 2011

Rule Behind Huge Patent Damages Dies at Hands of Federal Circuit, Second Rule Lives to Fight Another Day

You may have wondered why patent cases have seemed so vogue in the last decade or so for hot shot trial lawyers. Blawgletter would not presume to tell you the cause. But perhaps it stems from the fact that, as Willie Sutton said, "that's where the money is."

But that now looks so two days ago. Because, in Uniloc USA, Inc. v. Microsoft Corp., No. 10-1035 (Fed. Cir. Jan. 4, 2011), a panel of the Federal Circuit, which hears appeals in all patent infringement cases, held that a mainstay of huge awards in patent cases must go the way of the dinosaur and confirmed that another applies rarely.

Let's start with the basic rule on patent damages. Under 35 U.S.C. § 284, a patent owner may collect damages "in no event less than a reasonable royalty for the use made of the invention by the infringer". And "a reasonable royalty is often determined on the basis of a hypothetical negotiation, occurring between the parties at the time the infringement began." Uniloc, slip op. at 36.

The first mainstay -- the "25 percent rule of thumb" -- posits that, in your typical hypothetical negotiation, a patent owner would make a deal for one-quarter of the profit that the patent infringer expects to reap from selling or licensing its infringing product; the infringer would keep the rest (75 percent). Uniloc, slip op. at 36-37.

Despite the 25 percent rule's long tenure, ease of use, and numerical charm, the panel noted, its "admissibility . . . has never been squarely presented to this court." Id. at 39. So what does support the rule? Not much, the panel felt:

[T]here must be a basis in fact to associate the royalty rates used in prior licenses to the particular hypothetical negotiation at issue in the case. The 25 percent rule of thumb as an abstract and largely theoretical construct fails to satisfy this fundamental requirement. The rule does not say anything about a particular hypothetical negotiation or reasonable royalty involving any particular technology, industry, or party.

Id. at 45. Finding the rule "fundamentally flawed [as a] tool for determining a baseline royalty rate in a hypothetical negotiation", the panel held that "[e]vidence relying on the 25 percent rule of thumb is thus inadmissible". Id. at 41.

The panel then turned to the other mainstay of very large patent awards -- the "entire market value" rule. The EMVR compares the reasonable royalty that a patent owner proposes against the EMV of the infringing product. But:

The . . . rule allows a patentee to assess damages based on the entire market value of the accused product only where the patented feature creates the "basis for customer demand" or "substantially create[s] the value of the component parts." Lucent Techs.[, Inc. v. Gateway, Inc.], 580 F.3d 1301[,] 1336 [(Fed. Cir. 2009)]; Rite-Hite Corp. v. Kelley Co., 56 F.3d 1538, 1549-50 (Fed. Cir. 1995). This rule is derived from Supreme Court precedent requiring that "the patentee . . . must in every case give evidence tending to separate or apportion the defendant’s profits and the patentee’s damages between the patented feature and the unpat-ented features, and such evidence must be reliable and tangible, and not conjectural or speculative," or show that "the entire value of the whole machine, as a marketable article, is properly and legally attributable to the patented feature." Garretson v. Clark, 111 U.S. 120, 121 (1884). See also Lucent Techs., 580 F.3d at 1336-37 (tracing the origins of the entire market value to several Supreme Court cases including Garretson).

Uniloc, slip op. at 48. Because the product at issue didn't create the basis for customer demand or substantially create the value of the component parts, the panel ruled, the EMVR didn't apply.

If this all sounds abstract and largely theoretical, let's put some meat on the airy-fairy bones.

Uniloc accused Microsoft's "Product Keys" of infringing Uniloc's patent on a software registration system that deterred copying of the software. Uniloc won in a jury trial. Its damages expert proposed to the jury that the value to Microsoft of the infringing Product Keys equaled $10 per copy of Office and Word software. He then suggested $2.50 -- 25 percent of the $10 -- as a reasonable royalty. He checked the result -- $564,946,803 -- against Microsoft's Office and Word revenues -- around $19.28 billion -- and noted that the $564 million came to a mere 2.9 percent of the infringing products' entire market value. The jury awarded $388 million.

What does the decision mean? It looks like obvious bad news for anybody who relies on the 25 percent rule. And it should caution anyone who wants to invoke the entire market value rule.

Will it devalue patent cases in general? We doubt it. The amateurs have largely left the building already, and the efficient market has factored in the concerns. But the pros surely will take notice.